JSC VTB Bank (VTB), a Russia-based bank, and VTB Capital PLC (VTB Capital), a UK-based bank that is ultimately 94% owned by VTB, were sued by the CFTC for engaging in block trades with each other contrary to CME Group rules, in that the prices of the block trades were not “fair and reasonable.” According to the CFTC, between December 2010 and June 2013, the two companies engaged in more than 100 block trades involving CME Group’s Russian Ruble/US Dollar futures contracts. The CFTC alleged that the companies engaged in these transactions to transfer certain Russian Ruble/US dollar risk from VTB to VTB Capital. However, in doing so, said the CFTC, the defendants chose a price for their block trades that “typically” reflected the midpoint between the prevailing bid-ask spread of the over-the-counter RUB/USD swap. The CFTC said that, because the defendants did not seek other block trade prices from other counterparties, the prices chosen by the defendants for their block trades were not fair and reasonable prices, as required by CME Group rules. Thus the block trades were unlawful noncompetitive trades under the applicable CFTC rule. (Click here to access CFTC Rule 1.38(a).) To resolve the CFTC’s complaint, defendants agreed to pay a fine of US $5 million and to institute or enhance procedures to avoid noncompetitive transactions.
Legal Weeds: Block trades are a type of noncompetitive transaction permissible under rules of the Commodity Futures Trading Commission if they are executed strictly in accordance with the applicable exchange’s rules. If they are not so executed, the transaction may be a violation of not only the applicable exchange’s rules, but of applicable law and CFTC rules. (Click here for background regarding block trades in the article, “Block Trade Requirements Must Be Followed Strictly; No Chips Off the Old Block Trade Rules Permitted” in the January 10, 2016 edition ofBridging the Week.) According to CME Group, the prices of block trades must be fair and reasonable considering (1) the size of the transaction; (2) the prices and sizes of other transactions in the same contract at the equivalent time; (3) the prices and sizes of transactions in other relevant markets; and (4) the circumstances of the markets or the parties to the block trade. Here, according to the CFTC complaint, the price of the allegedly problematic block trades was the midpoint of the bid-ask spread of the related swap instrument. Moreover, VTB claimed that, at the time of execution of the allegedly problematic block trades, the market in the RUB/USD futures contract was illiquid. Given these circumstances, it is hard to understand how the CFTC concluded that the prices of the relevant futures contracts were not fair and reasonable. That being said, CME Group prohibits block trades between accounts with common beneficial ownership unless each party’s decision to trade was made independently. Given that VTB and VTB Capital appear to be under common beneficial ownership and acted in concert to effectuate a risk transfer from VTB to VTB Capital, it seems odd that the CFTC did not allege that this aspect of the relevant block trades was problematic, as opposed to the quality of the prices. Indeed, the CFTC noted in its Order that “[t]he block trades by design, did not create any market risk to the combined VTB entities because, ultimately, any financial gains and losses from these trades were consolidated on VTB’s books.” Ordinarily exchanges give wide latitude to the prices decided between parties to a block trade because such prices are reported to the public independently of trade prices in the ordinary market, are not included in the daily trading range and will not set off any conditional orders. (Click here to access CME Group’s Market Regulation Advisory Notice regarding block trades; click here to access similar guidance by ICE Futures U.S.) Regrettably, it is not clear what message the CFTC is endeavoring to provide traders and execution facilities regarding acceptable prices for block trades going forward.